How will central bank rate hikes affect the economy?

How will central bank rate hikes affect the economy?

In the face of inflation not seen in almost 40 years, central banks in the United States and the euro zone are beginning to raise interest rates, with tangible consequences for the real economy.

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This change in monetary policy, the Fed on Wednesday announcing a 0.75 percentage point rate hike, the largest since 1994, will have repercussions for both individuals and companies, but also for fragile countries.

Rising fuel prices truckers in the red
1652175074 279 Rising fuel prices truckers in the red

More expensive loans

For borrowers, this means an increase in the cost of borrowing, for example to buy a house.

“Real estate prices are already rising and this should only increase,” Éric Dor, director of economic studies at the IESEG School of Management, told AFP.

In concrete terms, the increase in central bank interest rates leads to an increase in the financing costs for the banks. The latter pass it on to their customers, companies or consumers who want to take out a loan.

On the other hand, for those who already have a loan, the situation will differ from country to country: “In France, there is a strong preference for fixed interest rates, so they do not evolve in line with the evolution of overall interest rates. The Iberian Peninsula tends to favor variable interest rates, the risk will be higher there and is already causing concern,” explains Mr. Dor.

savers at the party

Savers can benefit from interest rate increases, which should make the returns on financial products such as life insurance or savings accounts more attractive.

The interest rate of the latter is calculated according to the rate at which the banks lend themselves and according to the evolution of inflation.

“If the revaluation took place today, the proposed rate would be 1.7%,” up from 1% last February, explains Éric Dor. The next increase could come on August 1st.

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More exports, more expensive imports

The impact of rate hikes differs depending on the central bank that initiated them. Those decided by the Federal Reserve (Fed) will be particularly scrutinized: they started earlier and are more pronounced than those by the ECB, the first of which was due to take place in July.

“The Fed acted earlier and more vigorously, stopping its asset purchases and even starting to reduce its balance sheet, unlike the ECB,” said Eric Dor.

This makes the dollar more profitable and more expensive against other currencies like the euro.

Products denominated in American currency then become more expensive, as far as oil and almost all commodities are concerned, which mainly affects inflation outside the United States and thus increases prices in stores or at the pump.

But this decline in the euro against the dollar is beneficial for exporting companies, particularly to the United States.

Overall, “purchasing power is declining, but with increasing exports, jobs can be secured or even created,” recalls Mr. Dor.

In certain export sectors such as luxury or aviation, the depreciation of the euro will therefore have a positive impact on financial results.

Bigger risks outside of Europe

Although European countries are generally protected from the impact of this rate hike, particularly that of the Fed, this is not the case for emerging markets or poorer countries already weakened by the aftermath of the health crisis or the war in Ukraine and rising commodity and energy prices .

As with the euro, the rise in Fed rates will automatically cause the dollar to appreciate against emerging market currencies, adding to already higher inflation. It also pulls US Treasuries higher, which are then more profitable and much safer for investors.

“For countries that are already in trouble, like Turkey or Brazil, but even more so Argentina or Sri Lanka, this is very unwelcome because it raises prices while causing a flow of capital from those countries to the States,” which it says Éric Dor fears that even more will make it difficult to finance one’s own economy. At the risk of destabilizing them a little more.